In economics

Economics

Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...

, aggregate supply is the total supply of goods and services that firms in a national economy plan on selling during a specific time period. It is the total amount of goods and services that firms are willing to sell at a given price level in an economy.

Analysis

In neo-Keynesian theory seen in many textbooks, an "aggregate supply and demand" diagram is drawn that looks like a typical Marshall

Alfred Marshall

Alfred Marshall was an Englishman and one of the most influential economists of his time. His book, Principles of Economics , was the dominant economic textbook in England for many years...

ian supply and demand

Supply and demand

Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers will equal the quantity supplied by producers , resulting in an...

 diagram. The aggregate supply (AS) curve is usually drawn as upward-sloping in the short run, since the quantity of aggregate production supplied (Q^s) rises as the average price level (P) rises.

There are two main reasons why Q^s might rise as P rises, i.e., why the AS curve is upward sloping:

• Higher prices motivate profit-seeking firms to increase output. This is because of diminishing returns
  Diminishing returns
  In economics, diminishing returns is the decrease in the marginal output of a production process as the amount of a single factor of production is increased, while the amounts of all other factors of production stay constant.The law of diminishing returns In economics, diminishing returns (also...
  
   and thus rising marginal costs that arise because one or more of the inputs or factors of production
  Factors of production
  In economics, factors of production means inputs and finished goods means output. Input determines the quantity of output i.e. output depends upon input. Input is the starting point and output is the end point of production process and such input-output relationship is called a production function...
  
   does not change in the short run and is assumed to be fully employed at all times. Usually this is fixed capital
  Capital (economics)
  In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...
  
   equipment. The AS curve is drawn given some nominal variable, such as the nominal wage rate. In the short run, the nominal wage rate is taken as fixed. Thus, rising P implies higher profits that justify expansion of output. In the neoclassical
  Neoclassical economics
  Neoclassical economics is a term variously used for approaches to economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand, often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits...
  
   long run, on the other hand, the nominal wage rate varies with economic conditions. (High unemployment leads to falling nominal wages -- and vice-versa.)
• An alternative model starts with the notion that any economy involves a large number of heterogeneous types of inputs, including both fixed capital equipment and labor. Both main types of inputs can be unemployed. The upward-sloping AS curve arises because (1) some nominal input prices are fixed in the short run (as in the neoclassical theory) and (2) as output rises, more and more production processes encounter bottlenecks. At low levels of demand, there are large numbers of production processes that do not use their fixed capital equipment fully. Thus, production can be increased without much in the way of diminishing returns and the average price level need not rise much (if at all) to justify increased production. The AS curve is flat. On the other hand, when demand is high, few production processes have unemployed fixed inputs. Thus, bottlenecks are general. Any increase in demand and production induces increases in prices. Thus, the AS curve is steep or vertical.

AS is targeted by government "supply side policies" which are meant to increase productivity efficiency and national output. For example, education and training and research and development.

Different scopes

There are generally three forms of aggregate supply (AS). They are:

1. Short run aggregate supply (SRAS) — Within the time frame during which firms can change the amount of labor used but not capital (such as building new factories). This form demonstrates what happens to the economy under the most slack, when resources are underused. Upward shifts in SRAS generally increase output (y) but don't increase price (P). The SRAS curve is nearly perfectly horizontal. The concept is that wages (price of labor) don't change over the short run.
2. Long run aggregate supply (LRAS) — Over the long run, only capital, labor, and technology affect the LRAS in the macroeconomic model because at this point everything in the economy is assumed to be used optimally. In most situations, the LRAS is viewed as static because it shifts the slowest of the three. The LRAS is shown as perfectly vertical, reflecting economists' belief that changes in aggregate demand (AD) have an only temporary change on the economy's total output.
3. Medium run aggregate supply (MRAS) — As an interim between SRAS and LRAS, the MRAS form slopes upward and reflects when capital as well as labor can change. More specifically, the Medium run aggregate supply is like this for three theoretical reasons, namely the Sticky-Wage Theory, the Sticky-Price Theory and the Misperception Theory. When graphing an aggregate supply and demand model, the MRAS is generally graphed after aggregate demand (AD), SRAS, and LRAS have been graphed, and then placed so that the equilibria occur at the same point. The MRAS curve is affected by capital, labor, technology, and wage rate.

In a standard aggregate supply demand model, the output (y) is the x axis and price (P) is the y axis. An increase in aggregate demand shifts the AD curve rightward, bringing the equilibrium point horizontally along the SRAS until it reaches the new AD. This point is the short run equilibrium.

External links

• Elmer G. Wiens: Classical & Keynesian AD-AS Model - An on-line, interactive model of the Canadian Economy.